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Why You Should Like Thermal Energy International Inc.’s (CVE:TMG) ROCE

Today we are going to look at Thermal Energy International Inc. (CVE:TMG) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

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Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Thermal Energy International:

0.27 = CA$2.2m ÷ (CA$14m - CA$5.9m) (Based on the trailing twelve months to February 2020.)

So, Thermal Energy International has an ROCE of 27%.

See our latest analysis for Thermal Energy International

Is Thermal Energy International's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, we find that Thermal Energy International's ROCE is meaningfully better than the 9.0% average in the Machinery industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the comparison to its industry for a moment, Thermal Energy International's ROCE in absolute terms currently looks quite high.

We can see that, Thermal Energy International currently has an ROCE of 27% compared to its ROCE 3 years ago, which was 16%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Thermal Energy International's past growth compares to other companies.

TSXV:TMG Past Revenue and Net Income June 1st 2020
TSXV:TMG Past Revenue and Net Income June 1st 2020

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. You can check if Thermal Energy International has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Thermal Energy International's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Thermal Energy International has total assets of CA$14m and current liabilities of CA$5.9m. As a result, its current liabilities are equal to approximately 41% of its total assets. Thermal Energy International's ROCE is boosted somewhat by its middling amount of current liabilities.

The Bottom Line On Thermal Energy International's ROCE

Despite this, it reports a high ROCE, and may be worth investigating further. Thermal Energy International shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.

This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.